Wharf Real Estate Investment Company Limited (1997) Earnings Call Transcript & Summary

Good afternoon, everyone. A very warm welcome to Wharf REIC interim results presentation. You may download the PowerPoint from this QR code on the LED wall, and the recording of the event will be uploaded to our corporate website afterwards. We kindly request that attendees refrain from taking photos or videos during the event. Our management today include Mr. Stephen Ng, Chairman and Director; Mr. Horace Lee, Director; and I'm Angela Ng, Investor Relations Manager. Today, we will first go through the PowerPoint presentation before the Q&A session with our management. The theme for the presentation is Hong Kong Recovery Well Below Pre-COVID. Now, let's take a look at the results highlights. We are pleased to report sequential half-on-half improvement on retail revenue, but this improvement was overshadowed by the amortization of rental concessions granted during the COVID years. In addition, the office market remains weak. The valuation of IP had not yet bottomed out as the changing -- as the challenging environment persists. By comparison, hotels turnover is -- hotels turnaround is more visible, although it has been losing momentum since the second quarter. In terms of financial management, with HIBOR breaching 5% in June, our borrowing cost tripled in the first half. However, the rising costs will be mitigated by the reduction of debt to the lowest level in 4 years. The recovery pace of the market has been slow. Hong Kong retail sales only recovered to 85% of pre-COVID level in 2019, and tourist arrivals recovered to 37%. The slow recovery pace was led by multiple factors, including the global geopolitical tensions and economic uncertainties, a strong local currency as well as the very slow resumption in traveling logistics. Meanwhile, the office market vacancy rate is reaching over 2-decade high, and the situation has no sign of improvement so far. The overall recovery is further complicated by the mounting pressure on hiking interest rates and inflating costs. To navigate these headwinds, the group proactively adjust marketing spend to capture both local and tourist spending. Additionally, reducing debt has become a priority, and some long-term investments were disposed. Net debt reduced by HKD 6.1 billion to HKD 39.1 billion, with gearing ratio down to 20.1%. The group's premier Hong Kong IP portfolio had a proven track record in pre-COVID years, which set a high benchmark for recovery. Retail spot rent has stabilized and turnover rent contribution increased, but the growth was overshadowed by the amortization accounting. As a result, our retail revenue increased by 8%, reaching around 70% of the pre-COVID level. Overall, Hong Kong IP revenue reported a 2% increase which was significantly dragged by the decline in office segment. Despite rising manpower and energy costs, our efficient spending on marketing helped to offset the impact on profitability. Hong Kong IP operating margin improved by 3 percentage points to 86% under the high interest rate environment, the group's borrowing cost increased by HKD 0.7 billion year-on-year, resulting in 9% decrease in group UNP. IP valuation declined by 0.5% compared to last December. Cap rate remained stable. Core UNP, being the UNP of Hong Kong IP and Hotel, decreased by 5%. Dividend policy is maintained at 65% of core UNP, representing an interim dividend of HKD 0.67 per share. A strong financial position is crucial under the current business environment. Our current debt level is nearly the lowest level since the company was listed. Gearing improved by 3.1 percentage points to 20.1%. Average interest cost increased to 4.7%, mainly due to the floating rate debt. However, there is a possibility that this trend could reverse as some in the market expect the rate hike cycle may be nearing an end. Our interest cover was healthy at 4.8x, and we maintained a premium Moody's A2 rating with stable outlook. In the following slides, we will walk through the performance of our core assets in Hong Kong. First, Harbour City, which accounts for 74% of our core -- of our Hong Kong IP revenue. Harbour City saw a 9% increase in retail revenue and 60% in retail operating profit. Occupancy improved to 96%, with tenant mix we find to cater to both locals and tourists. The office portfolio also received more leasing interest from the investment and insurance companies targeting the Mainland customers, but the market is still lacking sizable demand. Occupancy of Harbour City office maintained at 88%. With over 500 diverse retail outlets, Harbour City maintains a balanced mix of trade with Fashion, Leather Goods, Jewelry, Beauty and Accessories account for over 80% of retail rental. Harbour City is more than just the largest shopping mall in Hong Kong but also an all-in-one destination with dining, entertainment and panoramic view of Victoria Harbour. Additionally, its convenient proximity to the high-speed rail station and various transportation options also make it a popular choice among the local and tourists. In addition, the engaging marketing strategies also helped the mall to stand out. One of the latest examples is the Disney 100th anniversary event hosting at Harbour City, Times Square and Plaza Hollywood, which has become a popular summer attraction. By integrating interactive technology, customers can explore the Disney-themed journeys at different corners of our malls while collecting virtual Disney stickers and redeeming prices on the game website. This combination of engaging digital and physical experiences is very effective in drawing footfall. Moreover, our tourist-centric offers have also been well received. The Canton Road frontage is a must-have location and showcase for the world's best brands. It is home to the flagships of Hermes, Chanel, Dior, LV, as well as the high-end jewelers such as VCA, Piaget and De Beers. Some of the key tenants are reporting full sales recovery comparing to pre-COVID. Our world-class tenant portfolio is carefully curated by our proprietary selection strategy, which helps to promote synergies among the top-tier retailers while minimizing tenant turnover and ensures the property is well maintained. Over 40 retail tenants have committed lease at Harbour City in the first half. And then, we will talk about Times Square. This vertical mall is continuously refining brand mix to broaden customer base. It is also enriching diverse experience to customers, including co-baking space, VR experience zone and Causeway Bay's most popular multiplex cinema. The mall occupancy was stable at 94%, but office is still facing multiple headwinds and the occupancy was 87%. Then switching to the regional mall, Plaza Hollywood, which is located atop the Diamond Hill station. The new Tuen Ma Line has greatly benefited Plaza Hollywood by providing an easy access to a larger population from both Kowloon and the new territories. It helps to effectively expand the catchment area of the mall. Occupancy was 96% in the first half. Our Hotel portfolio is operated under Niccolo brand and Marco Polo brand, which include The Murray in Central and the Marco Polo Hotels on Canton Road. Hotels reported feasible growth in gross operating profit, but the industry is facing mountain cost pressure. Our 5-star luxury hotel, The Murray has received more corporate demand and event bookings since the borders reopened. Similarly, Marco Polo Hotels on Canton Road has seen more tourist demand, and Prince Hotel was renovated and reopened by phases from May this year. And then, moving on to the outlook. The post-pandemic readjustment is still ongoing. The recovery pace of Retail and Hotel sectors are under challenge, while the Office market supply is expected to persist until a significant change in business climate. Another important factor to consider is the trend of cost inflation and timing for interest rate to peak out. In the last part of the presentation, I will walk through our efforts in sustainability. The group has formulated 2030 long-term target to reduce environmental footprint, and the progress has been on track. We remain a constituent of Hang Seng Corporate Sustainability Index with AA+ rating, and also 1 of the top ESG leaders in Hong Kong on Hang Seng ESG 50 Index. We have continuous asset enhancement to optimize operational efficiency across our portfolio, and solar panels are installed at Harbour City and Plaza Hollywood to promote the use of renewable energy. Meanwhile, the Star Ferry has 3 low-emission green ferry in the fleet and has participated in the full-electric ferry pilot program. The group's support in youth development also continues through an array of business in community initiatives, including our flagship project, WeCan. We are also making continuous efforts to promote corporate governance, talent development and workplace safety. That concludes my presentation. We will now proceed to the Q&A section.

[Operator Instructions] So now, may I invite Mr. Ng and Mr. Lee onstage, please.

Good afternoon. I should be on sick leave, but I'm not. I had a small operation. Strictly speaking, I am on sick leave, but because of the results announcement, decided it would be a good idea to show up and meet with yourselves face-to-face rather than trying to do it online. And I'd like to welcome you belatedly. Angela?

Yes. So may we have the first question from the floor, maybe Praveen from Morgan Stanley?

Can you hear me?

No.

Not sure.

Not [indiscernible]

Okay. This is Praveen from Morgan Stanley. I have 2 questions. The first 1 is retail sales. The dollar amount of retail sales as well as luxury retail sales that government reports has been actually improving every month throughout this year up to June, but your comments have been very conservative, if we read our press release. Just wanted to understand what are you seeing that we are not seeing from the company? And second related question is about, would you be able to share any qualitative statement about your retail sales for first half or second quarter versus market? And the third, which is linked to this is turnover rent. We saw your turnover rent growing year-over-year by 60%, and the base rent is kind of flattish, which makes a lot of sense. But considering you said a lot of your retail tenants have already reached pre-COVID level of sales, we would have expected turnover rent to be even higher assuming the ratio has not been changed. So is it that we're going to see that in the second half of this year?

Okay. Thank you for your question -- questions. First of all, you look at Hong Kong visitor arrival and Hong Kong retail sales. The numbers indicate that both hit a peak in March or April, and from then on, on a month-on-month basis, it's been declining. In absolute numbers, declining. So the peak for Hong Kong as a whole was at the beginning of the second quarter, and since then, it has not proceeded further and there has been little or no momentum in further growth. And that's affected everyone in Hong Kong, including our malls. Our malls are -- reported very similar trends as the Hong Kong overall totals. Some of our tenants did very well, but not all of them did. More wide, our year-on-year growth rates are significantly higher than Hong Kong's overall. That's partly because we started from a lower base than Hong Kong as a whole. Some of our tenants, in fact, are trading better than before COVID. But bear in mind, that does not necessarily -- the tenants -- these individual tenants' total sales in Hong Kong are doing better. It may or may not. Because over the last 3 or 4 years, they may have reduced the number of stores in Hong Kong. So the fact that their Harbour City store is trading better today than in 2019 or 2018 is 1 slice of the cake, i.e., the cake that we see, the slice that we see. They will see the total picture for Hong Kong, which we don't see. In fact, some of these tenants are already talking to us about expanding the store. Not many, but it does indicate that having consolidated some of the tenants -- consolidated their stores and store numbers. Some of them are looking at expanding the remaining stores which are performing, so that's favorable to us from our point of view. Now in terms of turnover rent, I think, the perspective needs to be taken this way. There's a base rent and there's a turnover rent. When a tenant's sales are not high enough for turnover rent to be paid, we don't get any turnover rent. When the tenant's sales picks up, for the first part of the pickup until the turnover rent catches up with the base rent, there is no turnover rent either. So it is not a simple formula because every lease is different and every tenant performs differently. Although overall sales are significantly better, the distribution of the sales growth is not even. So it is possible that some of the tenants who were underperforming previously have caught up and maybe on the virtue of paying turnover rent, or may have started to pay a small turnover rent. It is also possible that some of the tenants who were already paying turnover rent previously are now doing better. And therefore, for every additional dollar of sales, we get the slice of it in additional turnover rent. So looking at the global number can be very, very misleading sometimes. From our point of view, the second half is still very unclear. Major factors include, obviously, economic performance of source markets, Europe and North America. You may have noticed from statistics released by the Hong Kong government that long-haul visitors are still much weaker than they were previously. We get a good amount of recovery from short-haul visitors with the exception, we believe, of maybe not curiously, Japan and Korea. Japan possibly because of currency. The yen is simply too weak. And currency is a big factor in the whole equation. The fact that the Hong Kong dollar has been strong because of the peg -- has made Hong Kong expensive relative to renminbi, relative to the yen and most Asian and European currencies as well. So for as long as the U.S. dollar stays strong and for as long as, of course, the Hong Kong dollar is pegged to the U.S. dollar. And various economies in around -- in our source -- major source markets are uncertain, we are conservative about the second half. It's a very long 10-minute answer to your questions, I'm sorry.

May we have the next question, please? Sam from Jefferies.

Two questions, if I may. First is on the base rent reversion outlook for Office and Retail. We saw double-digit decline in Office revenue for Times Square, which seems to imply pretty steep negative reversion at Office. So can you please comment on that? And secondly, I just want to quickly check on the amortization schedule for rental reconcessions. So could you please also help quantify the impact for first half '23? And what would be the impact on subsequent period?

Okay. Office sector and Retail sector are, at the moment, performing in different directions. We see the Retail market recovering. In fact, in spite of the amortization of rent relief, Retail rent in the first half improved over the first half of last year. There is year-on-year growth. Whereas for Office, because of the general oversupply in Hong Kong, there is pressure on both occupancy and rent, and we see the Office oversupply situation continuing in the next 1 to 2 years at least, until major economies recover and until tenants start to regain appetite in committing to bigger spaces. And the other factor about Office -- the Office market is that a lot of tenants are reluctant to incur capital expenditure. So retention of tenant, in a way, is less difficult than before because with every move, there is capital expenditure. Now we understand, of course, some of the more aggressive landlords are prepared to subsidize capital expenditure. But we also have noticed that some of these -- some of the tenants who moved to the less prime office locations due to CapEx subsidy are finding it difficult to retain staff or to recruit staff at a time when talent is becoming a more scarce asset. So tenants will need to think twice about taking supposedly sweeter office leases if -- as a result that they stand to lose good staff. But we see that the Office market is still remaining soft. Within that soft Office market, our role is to maintain, if not, gain market share if possible. And 1 of the first things we would be doing and that we have already started doing is to renovate, to bring our offices to the -- physical state of our offices back to a more competitive state. We start with the common areas, and that will involve capital expenditure. And at the same time, of course, we need to make sure that our leases are flexible enough to deal with customer needs. Whatever the situation is today in the Office market, it is a buyer's market. And as a seller, we need to cope with buyer's demand, so that is how we intend to deal with it. In the Retail sector, different tenants are trading differently. And over the past few years, we have invested a good deal of energy in improving the tenant mix to make our malls more attractive to tenants and shoppers. And there are early signs of that strategy paying off in Harbour City. Times Square is still a work -- a piece of work in progress. And we don't have as good results to show yet, but that is going to be our next target. But it will take time. But we see, if the retail environment continues no worse than in the current state, we do see retail rent improving. The question you asked about amortization of rent relief, rent relief was mainly granted in 2020, 2021 and 2022, those 3 years. And according to the accounting standard, rent relief is to be amortized over the duration of the lease to the extent that most leases are not longer than 3 years. There are some special leases, but to the extent most leases are no longer than 3 years, we would expect the majority of the amortization to have been completed by the year 2025, being 3 years from 2022. And the amounts of amortization will be evened out as well. So first half of 2023, the half that we are reporting on, probably saw 1 of the higher -- the larger distortions, if I may use that term. But if you look at the underlying retail rent, total retail rent, the growth was satisfactory. Thank you.

Thank you. May we have the next question from Raymond of HSBC.

The first question is about tenant sales in Hong Kong.

Sorry, what?

Tenant sales in Hong Kong.

Tenant sales.

Tenant sales in Hong Kong. So can management quantify the tenant sales performance of your Harbour City? Because as you mentioned, you commented some of the tenants have already fully recovered in terms of sales versus the pre-COVID level. So can management provide us the guidance like quantifying the tenant sales level for the first half or even in the second quarter this year compared to pre-COVID level in 2019, so investor has a better gauge how strong your recovery is in this year? And the second question actually is also about retail market. Management mentioned that like the office market is still a buyer market. So when we look at the retail market, should it -- would it be fair to say it's now, like, lender's market or still a tenant's market at the moment?

Okay. Tenant -- total tenant sales, total tenant sales at Harbour City in the first half of 2023 is probably still about a quarter below pre-COVID. So the good news is there is still room for upside. The not-so-clear news is how quickly could we catch up or will we ever catch up? Hong Kong is part of the bigger problem. Will Hong Kong ever catch up? If Hong Kong does, next question is will Harbour City catch up? We don't have the answer, but it will take time. The recovery clearly is taking longer than some people expected. I described the Office market as a buyer's market. If I have to characterize the retail market, I wouldn't call it a seller's market. No, not yet, definitely. It's probably a neutral market where leasing interest has certainly increased. But on the other hand, some of the tenants are still hesitant about making long commitments. On the 1 hand, it varies from tenant to tenant. Some tenants are doing better than others, obviously. If they do better, they would have more confidence. At the same time, I think the Hong Kong recovery is also a factor that they need to take into account as well. So it's a bit of a neutral market, right? Thank you.

Thank you. May we have the next question from the floor, Mark from UBS.

It's Mark Leung from UBS. I have a follow-up question regarding on your sales comments on the Harbour City. Sales -- tenant sales for Harbour City.

The tenant sales, right?

Yes, yes. We are still maybe a quarter below the pre-COVID level. But if we look at other maybe luxury malls in Hong Kong, some of them are reporting even at par or even higher than pre-COVID sales. Could you comment on what kind of tenant mix we are tracking the tenant sales? Obviously, our luxury sales are doing really well, right? But how about for the other segments? I think that's the first question. And I think the second question is regarding on the Office. Because I think the Office rent was down by like 8% to 14% Y-o-Y. But if I look at the occupancy, actually, it's only largely flat or maybe slightly decline a few percentage points. Could you imply that is it mainly due to a really superior negative rental reversion? Or do we have any one-off expenses being booked in the Office segment?

Answering the second question first. Obviously, rent has been soft, so there is negative reversion in the Office sector, no question about that. Whereas in terms of vacancy, we're maintaining and hoping to gain occupancy in the coming periods. In terms of recovery compared to pre-COVID, a lot depends on the starting point pre-COVID. If your starting point was higher, it is possible it may take longer. If the starting point was mediocre, it is possible that recovery would be sooner or even over recovery. In fact, the same applies not only to any mall but to any tenant, any store. Some of the stores that I described as having recovered to pre-COVID levels may imply they were not doing that well pre-COVID. But in the intervening 3 years, for instance, their products may have improved, the brands may have become stronger. So the mere fact that they are trading better than before does not necessarily trade -- mean they are doing better than competitors, because reference is only pre-COVID rather than to other malls. I can only say that much. We're reporting how we did compared to pre-COVID, and so are our peers.

Question from Ken Yeung from Citi.

I think we haven't touched base on Times Square. I guess you mentioned about Harbour City already 75%, something like recovery pre-COVID. How should we be compare it versus Times Square? And do you think that -- I'm sure that Harbour City, the recovery, the performance is much stronger than Times Square. Do you think that this is more specific or basically, it's just Tsim Sha Tsui is closer to high-speed railway, definitely better than Causeway Bay? Is it district specific? So this is the first question. The second question is, I think, is for Horace, is, we do see that the investment portfolio have been down by something like HKD 4 billion. So do we have the plan to further sell down some of the securities in order to repay your debt?

Okay. Harbour City compared to pre-COVID is about quarter down. Times Square is probably about 1/3 down. And there's a -- the main reason is because Harbour City is a stronger mall with a more dominant market position in Tsim Sha Tsui, whereas there is less dominance for any 1 mall in Causeway Bay. It's a more balanced competitive landscape in Causeway Bay. We clearly recognize that Times Square has fallen behind in the past few years, and as I was implying, we are working on trying to regain some of the lost ground, but we're not ready to talk about those plans yet. To your second question about investment, what we sold in the second quarter of this year is mainly investments which were giving us a negative carry, i.e., where the dividend yield was lower than the cost of money. What we have left are mainly investments which would give us a positive carry even in today's market or at least a neutral carry, which means there is much less urgency for us to divest additional investment because they're neutral or even slightly positive carry. That's assuming interest rate stays where they are today. If interest rate goes up further then obviously, it will change the balance, and we would review it at that time.

[Operator Instructions] Simon from Goldman Sachs.

I got a quick question. Just given the fact that I think Harbour City historically been able to capture a lot of Mainland Chinese, and for whatever reasons that we've been discussing, macro currency, it seems like that the Chinese are returning quite slowly. Wanting to understand how you're thinking about your tenant mix? Because obviously, historically, it seems like you're very skilled towards this group of Mainland Chinese. How are you thinking about your positioning, assuming that they may not come back so quickly? That's the first one. And then second one, it sounds like you are maintaining your equity portfolio as long as the interest rates is upholding at this current level. So in that -- if the interest rate further rise, does that mean that you're going to be disposing more? That's one. And then secondly, how are you thinking of your borrowing cost? Because I remember last time you talked about that, it's very difficult to hedge. Whether you have any change in your mentality now or you're thinking about that? Okay.

Okay. Harbour City, as large as it is, it's not a mall that caters to Mainland business. That happens to be the 1 piece which catches most attention. But in fact, there's a lot of business from locals, and we certainly consider locals as an important source of business for our tenants. To start with, there are a lot of offices within Harbour City, and the office tenants or people working in the office tenants are a major source of consumption within Harbour City. We also draw consumption from neighboring office buildings, and so forth. What is most conspicuous at Harbour City is, of course, Canton Road. And Canton Road is where the big luxury brands are, and they draw the most Mainland tourists, and that's why the perception is it is a tourist mall. It is not. We rely very much on local consumption, and in the course of -- particularly in the course of the COVID period, you will remember we did very well in gaining additional market share in the local market. Post COVID, we have changed the marketing strategy. We are investing less in price promotion. We are investing a lot more on events and publicity opportunities, and that is drawing both locals and tourists. The equity -- on the equity portfolio, I thought I already answered that question. But in case interest rate rises further, and if as a result of that, some of our remaining investments would turn from neutral carry or positive carry to negative carry, we would reassess the situation. But if -- as long as they continue to give us neutral or better carry, we don't see urgency in liquidating the portfolio. And interest rate. We took advantage of a low interest rate environment for a long time, at least since this company was separately listed at the end of 2017. And regularly, we considered the cost of hedging, i.e., going fixed from floating. And invariably, we always came up with the answer that over the medium term, it would be favorable to stay in floating, and we continue to hold that view. While currently, the fixed rate is high -- sorry, the floating rate is high and we don't expect the floating rate to go back to what it was pre-2022, not for a very, very long period. But on the other hand, we don't expect interest rates to stay at 5-plus percent for a very long term either. So our current assessment is we would stay in floating.

[Operator Instructions] Karl from Bank of America.

A couple of questions. Just wanted to ask about occupancy costs? I can go back and do the math, but looks like you said retail rental income was back to around 70% of pre-COVID level and sales were back to maybe 25% to 1/3 down. So looks like occupancy costs, I guess, comment on occupancy cost? Where do you think it is? Is it still higher than where historically it was or lower? Where it can go? And second is, any comment on CapEx? Since you mentioned you're upgrading some of the office fixtures if the -- if you could talk about the office -- the CapEx outlook? And also a bit going into next year, if you are going to do something else -- over Times Square, if CapEx may also pick up as well?

Okay. Occupancy cost today is obviously a lot lower than immediately pre-COVID. On a more wide level, we consider it reasonably affordable. It's about -- it's under 20%, so that's the reasonable level. But there is great discrepancy from tenant to tenant. Some of the tenants are doing very, very well and are enjoying occupancy costs of -- in the low teens, but others are not. Some of them are still struggling to the extent that they may not be staying with us, either voluntarily or involuntarily. So this is a -- I think it's fair to say the recovery has been very, very uneven. Some people are doing much better than others but on a more wide basis, obviously, the occupancy cost is a lot more affordable than before, and we're comfortable with it. Capital expenditure for Times Square, we don't know yet. We haven't finalized our plans yet. And for Harbour City, the capital expenditure will be incurred over a period of several years, so we don't expect that to put much burden on the cash flow. The reason why it cannot be done all at once is because we have a lot of remaining tenants, and we need to program it so as to cause the minimum disruption to existing tenants. So I don't expect the capital expenditure in the second half of this year, for instance, to raise any eyebrows.

Thank you. So in the interest of time, we will receive the last question from Jeff from DBS.

I have a question regarding the interest of making new acquisitions. Given the top priority is on debt reduction as a result of high interest rate or prolonged interest rate of cycle, does this mean that it is less likely for Wharf REIC to make any new investment, new acquisitions in the foreseeable future?

No, I don't think they are mutually exclusive. If we find the right opportunity, we would certainly be able to finance it either by liquidation of the remaining investment portfolio or by debt. At the moment, our debt level is -- gearing is 20%, reasonably low, and we've been able to repay our debt quite well. I think 1 of the slides shows you a couple of years ago, our net debt was HKD 52 billion, and it is now down to HKD 39 billion, so we've been able to generate something like HKD 14 billion of cash within a few years. And then on top of that, we've got a portfolio of investment. So if the right opportunity comes along, we'll be able to fund it. Thank you.

So thank you for answering the last question. So we will consider this presentation to be concluded. Thank you for joining us today.

Thank you very much. Can I go back to my sick leave?